Monday, November 5, 2007

Robust Economy Needs No Rejuvenation from UK MPC

Like a healthy person who has just taken a dangerous drug under the watchful eye of a team of doctors, the UK economy is under scrutiny by the nine members of the Bank of England's monetary policy committee for signs of adverse reaction.

But the economy still appears to be in rude health despite a freezing of liquidity in financial markets which left Northern Rock in casualty after a run on the bank by depositors.

Elsewhere, the economy's lack of untoward symptoms has led 55 of the 60 economists polled by Reuters to expect the MPC to decline following the US Federal Reserve in cutting interest rates just yet.

They expect the Bank's main rate to be left unchanged at 5.75 per cent on Thursday. Indeed, on the strength of the data alone, the MPC might arguably have raised rates at this week's meeting.

Vicky Redwood of Capital Economics said: "In August the committee had a tightening bias. The data have come in even stronger than the committee thought back then, which could have an increasing feeling on the committee that another rate hike would be necessary."

The MPC appears to have been taken aback by the resilience of the economy.

The minutes of last October's meeting, when David Blanchflower was the only member to have voted for a cut, suggested that a pre-emptive reduction might be on the cards in November - particularly since this is one of the four months when the MPC makes its decision on the basis of new projections for inflation and growth.

But recent comments by MPC members have been in wait-and-see vein.

This has led expectations among Bank-watchers to yo-yo. They thought rates were on the way up in August; then they expected rates to fall quickly. Now only a handful of economists expect a cut this week, compared with one in four a few weeks ago. The majority expect rates to come down next year.

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Philip Shaw of Investec is one of those who had expected an easing this week but acknowledges that: "Over the past few weeks the UK economy has exhibited signs of greater momentum - retail sales growth has been buoyant, the latest Nationwide house price figures point to some resilience in the housing market and gross domestic product growth, for now at least, remains above trend."

Annual GDP growth in the third quarter was 3.3 per cent - its fastest annual pace in three years - compared with the 3 per cent the MPC had pencilled in in August.

There have been signs of weakness. Last week's survey of manufacturing purchasing managers was down, but not by enough to push the MPC into rate cuts. The softening in the housing market, as Kate Barker, one of the four external MPC members noted last week, does not amount to a decisive slowdown.

The threat from inflation has receded, making space for the MPC to cut rates, but it is more concerned about the threat from rising oil and food prices to inflation. Consumer price inflation fell more sharply than MPC projections - to 1.8 per cent - in September, which is below the Bank's 2 per cent target, and the pound has reached a 26-year high against the dollar, which has a damping effect on the economy.

All of this means that the economy may need to slow more sharply than the MPC thought necessary to head off an inflationary threat.

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